Abstract
Overlapping-generations (OLG) models have recently emerged as the unifying framework for studying a wide range of fiscal policy issues including the crowding out effects of budget deficits (e.g. Auerbach and Kotlikoff, 1987; Frenkel and Razin, 1987). As their most attractive features, OLG models stress the intertemporal effects of fiscal policy changes and allow theoretical analyses to be based on solid microfoundations. In this chapter, we study the effects of public debt on capital accumulation in a numerical two-country OLG model. The fiscal policy experiment considered is a lump-sum tax cut over a specified number of periods in one of the two countries. We consider the case of two equally sized countries as well as the case of a small open economy. The model assumes that both countries produce the same good and that capital is perfectly mobile between the two countries. Crowding out of real capital is exclusively related to finite horizons of private households because we do not allow for Barro-type intergenera- tional transfers (Barro, 1974).
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